Saying that "mortgage features that are restricted in the Dodd-Frank Bill such as longer terms, interest-only periods and flexible payment designs are quite common in other countries and are not associated with higher rates of default", the Mortgage Bankers Association (MBA) today released a study comparing mortgage products in the United States with those in much of the rest of the world.  

Not surprisingly the study found that restrictions in the new financial reform act could limit the availability and flexibility of mortgages in the future.

International Comparison of Mortgage Product Offerings is the result of a study conducted by Dr. Michel Lea, Director of the Corky McMillin Center for Real Estate at San Diego State University and sponsored by MBA's Research Institute for Housing America.  The study examined the structure of the housing market including the homeownership rate, interest rates, government market support, default and foreclosure, and mortgage characteristics in 12 developed countries.  The mortgage characteristics included:

• Interest rate determination - fixed versus variable;
• Product variability;
• Prepayment penalties and early repayment;
• Amortization and term and the prevalence of interest-only loans;
• Determination of product design;
• Mortgage funding;
• Changes in product characteristics in response to the current crisis.

 Dr. Lea said, "The U.S. has traditionally had one of the richest sets of mortgage products available, offering a variety of adjustable rate mortgages, amortization choices and terms, along with long-term fixed-rate mortgages.  As a result of the mortgage crisis, the market shifted to primarily fixed-rate mortgages, mainly driven by the historically low mortgage rates. As this shift is likely to remain under the guidelines of the Dodd-Frank Bill, it is important for those implementing the regulation to consider whether such a dramatic and permanent shift in the mortgage market will do more harm than good."

Very few other countries offer government support to the mortgage market.  The study found that only the U.S. the Netherlands, Canada, and Japan offer government guarantees or mortgage insurance and only the U.S. and Korea have any type of government sponsored enterprises.  Still, other countries do have high rates of homeownership; the U.S. in fact, is only in the top half of the countries studied with Spain having by far the highest rate. 

Dr. Leo said there is no easy answer to about desirable features in a mortgage; it depends on whether the viewpoint is the borrowers or the lenders. "Features attractive to borrowers may be costly or impossible for lenders to provide and in turn, features attractive to lenders may not be acceptable to borrowers. Though there is no perfect mortgage, the dominant instrument in any country represents a balance between borrower and lender & investor needs. Regulation may have an important influence if it bans or dictates certain features, and history too may play a role as an instrument that has been dominant in a market for a long period of time is familiar to both borrowers and lenders and may be difficult to dislodge" 

Mortgage funding world-wide is based on three primary sources; bank deposits, mortgage backed securities (MBS) and mortgage bonds, with institutional investors playing a minor role in Canada, the Netherlands, and Germany.  The U.S. relies heavily on MBS for funding (approximately 60 percent) while Denmark's funding is almost entirely from bonds.  The other countries have a mix with deposits making up at least 50 percent in all nations except the U.S., Denmark, and Spain.

The study found that the U.S. is unique in its reliance on long term fixed-rate mortgages (FRMs), a product which barely exists in many of the other countries. In 2009, 95 percent of mortgages written in the U.S were long-term fixed-rate; France is the only other country where these constitute a majority.  In Australia, the UK, Ireland and Switzerland the market is totally dominated by various combinations of short and medium term fixed and variable rate products. 

The dominance of deposit based funding and thus bank lending partially explains the dominance of ARMs in many countries.  These are a natural product for banks that hold loans on balance sheet funding with deposits as they minimize interest rate risks.  Of the ARM countries in the survey only Spain relies on the capital markets for a majority of funding.

Most countries, including the U.S. have average amortization periods of 20 to 30 years.  In a few countries, notably Spain and Finland, the period is much longer although 50 and 60 year mortgages are not widely used.  In Japan there is a multi-generational 100-year mortgage.

The U.S is also in the minority when it comes to pre-payment penalties.  In most countries except the U.S., Denmark, and Japan, fixed-rate mortgages are typically subject to penalties, usually to compensate the lender for lost interest over the remaining term. 

The study says that, while some believe that the fixed-rate mortgage (FRM) is the ideal consumer mortgage instrument for all borrowers; its use does have significant drawbacks. In effect, the cost of the pre-payment option is socialized, with everyone paying a premium in the mortgage rate for the option. This contrasts with the European view that only borrowers who exercise the option for financial advantage should pay the cost.

Non-performing mortgages were consistently below 2 percent in all of the nations studied from 2001 to 2007.  When the rate took off in the U.S., it went up only slightly in the other countries.  Spain, Ireland, and Portugal topped out at less than 3 percent while the U.S. soared to 10 percent.

Regulation post housing crisis may have a significant impact on future mortgage product designs.  Thus far countries outside the U.S. have made only minimal changes, mostly in the loan-to-value and loan to income areas.  However several countries including Canada, Australia, and the UK have made or indicate they intend to make changes that will further tighten lending standards.

The study concludes by asking what will be the likely effects of the Dodd-Frank legislation on mortgage product design.  Lea found that the legislation will likely perpetuate the move toward FRMs; gravitating toward "vanilla, qualified mortgages."  Limiting or prohibiting pre-payment penalties constrains the availability of lenders to match fund medium-term FRMs and will reduce the effectiveness of covered bonds as a financing technique for lenders.  "Qualifying ARM borrowers at a fully amortizing payment at the highest possible rate over a five-year period is likely to reduce ARM qualification and volume."

The study also concludes that legislative and regulatory restrictions on features like interest only mortgages, low start rates, and negative amortization will reduce credit availability for many households and there will be less ability to offset the tilt effect of FRMs where the burden of the mortgage is higher in the early years. 

Finally, "lower default rates in (other countries) may reflect stricter enforcement of lender rights.  All countries in the survey have recourse lending and anecdotal evidence suggests it is enforced

 "The U.S. housing market is not operating in a vacuum and therefore should not be assessed in one. This study aimed to examine how different mortgage products perform in various other countries to help better understand if the mortgage product designs themselves are flawed. By comparing the performance of mortgage products internationally, we see that many countries are experiencing lower default rates than the U.S., despite having a significant share of products such as adjustable rate mortgages and interest only loans. This indicates the problem with loan design in the U.S. during the crisis was one of a mismatch between borrowers and particular loan designs - not the existence of the loan features themselves. In addition, the lower default rates may reflect stricter enforcement of lender rights as all countries in the survey have recourse lending.  By focusing regulation on loan product design, borrower choice will be deeply impacted as products that are commonplace in other countries will be considered "unqualified" for American borrowers," said Dr. Lea.